There are many different types of financial statements, each with its own requirement and purpose. Yet, they are often lumped in as a category. If you do not know the differences in financial statements, it is easy to get lost in the sea of paperwork. This guide to the 4 major financial statements provides clear-cut answers to the use, purpose and audience for 4 most common financial statements you will encounter.
It can help you understand and meet your financial reporting requirements, allowing you to bypass any fines and fees associated with skipping a mandated filing. So read on to understand more about financial reporting, financial statements, and the easiest way to file these financial reports with the SEC.
What Are Financial Statements?
First things first: What exactly are financial statements?
Financial statements discuss a company's financials. This may sound obvious, so let's look a little deeper.
- Balance sheets go into details about a company's income, assets and liabilities. They are a snapshot of a particular moment in time.
- Income statements go into detail about a company's revenue and expenses over a time frame, such as a quarter or a year. The income statement also includes net income, or the gross income minus the expenses.
- Cash flow statements show how cash moves in and out of the business. How does the company make money, and how do they use the income to pay their debts and meet financial obligations such as salaries or rent?
The financial statements which we are discussing are used by for-profit companies. Nonprofit companies are also required to make financial statements, but the structure and format of these differ.
Now that the basics are clear, let's examine the most common kinds of financial statements in detail.
Balance Sheet
Balance sheets indicate a snapshot of a company's finances at a point in time, such as the end of a quarter. These statements convey exactly how much the company is worth by examining three things: assets, liabilities and equity. Let's explore each of these categories:
- Assets: Assets refer to anything the company owns and can use. Real estate, inventory, equipment, patents and licenses, cash and other tangible assets fall into this category.
- Liabilities: Liabilities are anything owed by the company. From debts to expenses to deferred revenue, if it is an expense, it is listed in this column on the balance sheet.
- Equity: Equity reflects what is owed to the business owners. It is common (though not required) for owners to pay themselves whatever money is left over after the liabilities are subtracted from the assets.
Because balance sheets are only a snapshot of time, they are most useful as points of comparison. A company can compare the end of quarter 1 of the current year to the end of quarter 1 of the previous year. Balance sheets do not show every transaction from the quarter (these are reflected on the income statement, which is discussed below).
Balance sheets also provide a high-level glimpse at the overall financial health of the company, which may be useful to investors. If debts and liabilities outweigh assets, the company is clearly struggling.
Income Statement
As mentioned above, an income statement shows the company's income and its expenses. Think of it as a business log that shows all the revenue and expenses in between the period of time reflected on the balance sheet. Typical categories that are listed on an income statement include:
- Revenue: Revenue reflects the total amount of money earned during the time period.
- Cost of goods sold: Often abbreviated as COGS, cost of goods sold reflects the total cost it takes to produce the goods that are sold for revenue.
- Gross profit: Gross profit is the revenue, minus COGS.
- Expenses: Expenses indicate how much money was spent overall during the time period.
- Operating income: Operating income is the total of business profits minus operating expenses, which include things like rent and labor.
- EBITDA: EBITDA is an abbreviation that means "earnings before interest, depreciation, taxes, and amortization."
- Depreciation: Depreciation shows the loss in value of an asset over time, and is calculated using a formula.
- Income before taxes: This is the total income minus costs without accounting for taxes the company owes.
- Net income: Net income takes the revenue and subtracts all costs to show the real profitability of the business.
- Earnings per share: Earnings per share takes the company's income and divides it by the number of available shares.
Because the income statement covers a period of time, such as a quarter, stakeholders cause the income statement to get a clearer picture of the business's overall health over time. The longer time frame can indicate trends and aberrations, such as spikes in revenue or in expenses.
Cash Flow Statement
Cash flow statements provide a direct look at the way money moves in and out of the business. There are three categories shown on the cash flow statement:
- Financing activities — such as financing obtained through debt or equity. Any debt issued or repaid, as well as equity issues or stock shares repurchased, can be found in this section of the cash flow statement.
- Investing activities — such as cash from the purchase or sale of real estate, equipment, business autos or other investments. The investment section also lists the purchase or sale of any equipment or assets — tangible elements you may not traditionally think of as investments in the traditional sense — which are held by the business. Other investment transactions that fall into this category include mergers and acquisitions, as well as business loans the company has taken on or made to its customers.
- Operating activities — which encompass any cash found in accounts receivable or accounts payable. Wages, interest payments, income tax payments and other expenses associated with the day-to-day process of running a company are also found under the operating statements part of the cash flow statement.
Both businesses and investors can use the cash flow statement to understand the business health and make decisions.
Investors will peruse the cash flow to determine whether to buy or sell the stock. If the business has a consistent cash flow, it is an indication of a healthy company that may make a stable investment. If the company has erratic cash flow, it could be a sign that share prices will drop because the company is in trouble.
Internally, stakeholders can use the cash flow to identify strengths and weaknesses. This information then informs subsequent business decisions.
Statement of Shareholders’ Equity
Of all the types of financial statements mentioned above, this final statement may be the least familiar. This statement outlines any ownership interest changes for business shareholders. This form is also referred to as the statement of stockholders’ equity; these names can be used interchangeably.
On the statement of shareholders’ equity, you will find the amount of equity listed. This calculation is arrived at by subtracting the company's liabilities from its assets.
You will also find detailed information about different types of equity, such as:
- Common stock, which allows shareholders to vote on important company decisions, but gives the lowest level claim on assets to those investors
- Preferred stock, which is a premier type of share that entitles holders to more of the company's assets and earnings than the common shareholders
- Retained earnings, which are the earnings retained by the company after it pays dividends
- Treasury stock, which are stock shares repurchased by the company as a means of boosting share prices or protecting the company's ownership stake
- Unrealized gains and losses, which are gains and losses the company has not cashed in (for example, by selling shares)
- Additional paid-up capital, which is how much investors pay over the face value of the stock
Using Technology to Automate Financial Statements
Now that you understand the major types of financial statements, let's look at technological features that make it easier to prepare and file statements with the SEC:
- Financial Reporting Software: Cloud-based financial reporting software with collaborative features allows teams to quickly source data, compile financial statements and make necessary filings in a timely and efficient manner.
- XBRL Tagging Functions: XBRL is a markup language required by the SEC for financial reports. Software that supports intelligent XBRL tagging function streamlines the use of this language for commenting and tagging, fulfilling an important role in the regulatory process.
- AI Review/Analysis: AI reviews completed forms for inconsistencies and errors, flagging things for manual review. AI double checks that no requirement elements are missing, helping companies prepare and file accurate forms with less labor and overhead than manual review.
- Collaborative Data Rooms: Collaborative data rooms, or virtual data rooms as they are also known, provide a safe and secure place for due diligence, data review and audits.
DFIN’s flagship product, ActiveDisclosure, incorporates all of these technologies with other need-to-have features. ActiveDisclosure is a cloud-based financial reporting software capable of supporting teams with features like track changes. Excel integration allows for one-click importation of financial data, reducing the likelihood of errors. AI analysis provides peace of mind, as do best-in-class security features that safeguard critical data with end-to-end encryption. Clients save money, prepare forms faster and realize 20% gains in efficiency by switching to ActiveDisclosure.
Now that you understand the differences between these forms and the easiest way to file financial reports, get the tools you need to quickly and confidently prepare and file any of these reports before the next due date. Try ActiveDisclosure from DFIN today.
